What is a dollar anyway?

Minyanville's five things you need to know to stay ahead of the pack on Wall Street:Despite reaching levels that are technically oversold during themonth of June, the greenback just can't catch a break. What's goingon? What is a dollar? Why do we care whether it goes up or down invalue? Isn't the dollar I'm holding today the same as it wasyesterday? Why can't the Fed just print more dollars?

1. What is a dollar anyway? What does it mean?

The dollar is simply a banknote issued by the U.S.government that is mandated by law to be used as legal tender for alltransactions.

Although the dollar used to be backed bygold, today it is backed simply by the promise of the government thatit will be convertible in an exchange.

Got faith? Good, you'll need it, because faith is the only thing standing betweena dollar bill as exchangeable for say, a banana, and just a blank sheetof paper.

2. OK, OK, I got faith aplenty, so where do all our dollars come from, and why can't the Fed just print more money?

The Fed can print money.

And the missing M3 money supply data (which the Fed abruptly stopped publishing this spring) suggests they do. A lot.

But every dollar created dilutes the value of a dollar already in circulation, causing it to weaken.

Ofcourse, we don't notice this dilution immediately unless we traveloutside the country, and if everything we consumed was produced here inAmerica we probably wouldn't notice a weak dollar at all! Yippee!

Wait, did you see the trade report this morning? The trade report is what we import (buy) compared to what we export (sell).

D'oh! We ran a trade deficit of $62 billion dollars.

3. OK, so, we're spending more than we're making, andthe Fed is printing money to make up the difference. How does the Feddo it?

The Fed "prints" money through three mechanisms. Theeasiest way is through the Fed's Open Market Operations. Through openmarket operations, the Fed buys and sells, literally, Treasuries thatare trading in the "open market." If the Fed buys Treasuries, then thedollars it uses to buy them become available to banks to lend. If itsells Treasuries, the dollars get taken back.

Thesecond mechanism is lowering the percent of deposits banks are requiredto have on hand - thereby increasing the pool of available money tolend.

The third is through their "discount policy." The discount rate is the interest rate charged to commercial banks andother depository institutions on loans they receive from their regionalFederal Reserve Bank's lending facility. The Fed can grow money byreducing the discount rate.

Dollars are literally printed by the Bureau of Engraving and Printing.

4. Trade deficit, weaker dollar... I kinda get it. TheFed has to print more money. But the more money they print, the weakerthe dollar gets. Who is paying for all of this and what's theconnection with foreign central banks?

Because Americans as a whole spend more than they save,both individually and collectively as a government, that money has tocome from somewhere.

Since the more money the Fedcreates, the weaker the dollar gets, how do we get all these dollars tospend without collapsing the currency?

One way is through the purchases by central banks of countries like China and Japan.

We have to "sell" our Treasury bonds to countries willing to buy our debt, paying them interest for financing our spending.

Foreigngovernments all over the world also use the dollar as a foreignexchange reserve, allowing them to control their own currency,increasing or decreasing it compared to other currencies, and tomaintain stability of their currency in the event of an economic shock.

Because the dollar is perceived as the most stable currency in the world (note: key word is perceived) countries are willing to finance our spending by purchasing dollars and bonds.

But,if they begin to perceive they are not being adequately compensated forthe risk of holding our debt, or if their dollars are depreciatingfaster than they like, these countries will demand a higher interestrate to buy our bonds. So, a weak dollar can lead to higher interestrates! That affects you, Mr. or Ms. Homeowner-Credit Card Spender-Business Professional-Student!

5. Ok, so bottom line is this for me: In the simplestterms, what are the advantages or disadvantages of a stronger or weakerdollar?

Weak dollar - Advantages- Easier for U.S. companies to export goods because foreign currencies can buy "more" against the weaker dollar.- Tourism increases because foreign visitors find it less expensive to visit.-To an extent, foreigners will view investment opportunities here morefavorably since they can buy more for their yuan/yen/euro/pound, etc.

Weak dollar - Disadvantages-Higher prices for consumers. (We don't notice this because the Chineseyuan is tied to the dollar in a tight range and most of our importscome from China - just look at your shirt and your shoes!)- Higher interest rates, i.e. higher cost of money to consumers.- More expensive to travel abroad.